Financial Statement Analysis - D366

Complete to the end of Lesson 7

Which term describes financial statements that provide a complete and faithful representation of the firm's economic performance, financial position, and risk?

Quality

Which is an example of a business strategy that directly impacts a firm's ability to project future business activities?

Ski equipment manufacturer caters to professional skiers

In many industries, products and ideas are quickly copied. What does the original entrant into the market have?

First-mover advantage

Which company's financial statements would have the highest accounting quality?

Law firm with steadily growing service revenue that serves a variety of industries

What is the purpose of the financial analysis step "Analyze Profitability, Growth, and Risk"?

To assess the rate of return relative to competitors and to risk

Which of Porter's Five Forces depicts vertical competition in the value chain?

Buyer and supplier power

Why is Porter's Five Forces a good measure for depicting horizontal competition in the value chain?

Rivalry among existing firms and potential entry

What is an area in which Porter's Five Forces framework is used?

Industry competition

A student's choice of lunch options is a strong example of which Porter Five Forces?

Threat of substitutions

What is likely to happen if many new businesses enter a market?

Competitive rivalry will intensify.

A firm is trying to determine if its customers are highly price-sensitive or relatively insensitive.

Which of the economic framework attributes would apply to this analysis?

Demand

A chain retail store's products are also offered at many other retail stores but at higher prices.

Which competitive strategy is this store implementing?

Product differentiation strategy

A coffee company offers high-quality products that may be customized to each customer's taste, excellent customer service, and an inviting atmosphere.

Which competitive strategy is this company implementing?

Product differentiation strategy

Which statement is accurate regarding accounting quality?

Accounting information should be a fair and complete representation of the firm's economic performance, financial position, and risk, and provide relevant information to forecast the firm's expected future earnings and cash flows.

Which statement is accurate regarding common size financial statements?

Common-size financial statements must be carefully interpreted, and are simple but powerful tools for analyzing financial statements.

Which financial statement analysis tool is helpful in highlighting the relative rates of growth in financial statement amounts from year-to-year and over longer periods of time?

Percentage change financial statements

Which is an accurate statement regarding market efficiency?

Market efficiency describes the degree to which the capital market impounds information into security prices.

A coffee company is estimating the financial liabilities, financial assets, and common equity capital that it will need to finance its net operating assets for the upcoming quarter.

Which activity below is performed under step 1 of forecasting?

Projecting revenues from selling products and delivering services to customers

Which activity below is performed within step 2 of the forecasting process?

Projecting selling, general, and administrative expenses and operating income

Which activity below is performed within step 3 of the forecasting process?

Projecting the operating assets and the operating liabilities

Which activity below is performed within step 4 of the forecasting process is the company in?

Projecting the financial liabilities, financial assets, and common equity capital necessary to finance net operating assets

Which activity below is performed within step 5 of the forecasting process?

Projecting any nonrecurring gains or losses and changes in retained earnings

Which activity below is performed in step 6 of the forecasting process?

Determining how the firm will likely use its financial flexibility to balance the balance sheet

What does external validity mean in terms of forecast assumptions?

External validity means comparing forecast assumptions to industry averages and to the firm’s past performance and strategies.

What is a benefit of articulation across financial statements during the forecasting process?

Reduction in the possibility of errors from inconsistent assumptions.

Quality accounting information is fair and accurately represents the firm’s finances and risk, and is what allows a firm to forecast expected earnings and cash flow.

What does a high-quality balance sheet inform?

Resources expected to result in future economic benefits

What does a high-quality income statement inform?

Consumed resource costs, including those used in the production process

How are high-quality notes used in financial statements?

They provide additional information to improve the understanding of accounting methods, as well as judgments and estimates managers made.

A firm’s income statement included both revenue that the firm could collect and revenue that the firm was unable to collect during that period. It also did not include losses for that period.

What would be determined when the firm’s income statement is analyzed?

Including revenue the firm was unable to collect is evidence of low accounting quality, as that revenue should not have been included.

Which statement describes the concept of accounting quality?

Some accounting standards result in a company's inability to faithfully portray underlying circumstances.

Which scenario is an example of delayed maintenance?

A company’s CFO decides to repair a manufacturing line next quarter, so as not to impact current period reported income

What is an incentive for upward earnings management?

Management’s compensation might be increased if employment contracts are based on earnings or stock prices, and it might make jobs more secure for senior management since the company is performing well and avoiding negative results.

What is an incentive for managing earnings upward?

Increase share prices and maximize manager gains from a sale of personal ownership interests

What is an incentive for managing earnings downward?

Potential competitors might deem the industry to be unprofitable and be discouraged from entry.

Which answer addresses deterrence of earnings management?

The possibility of a resulting dramatic decrease in stock price can deter earnings management, and earnings management can be deterred by strong corporate governance.

What is an example of real earnings management?

Overproducing inventory to decrease cost of goods sold

Which criteria are needed for recognizing a liability to ensure a high-quality balance sheet?

There is a probable future sacrifice of some economic benefit because of a current obligation,and there is little or no discretion to avoid the transfer of a present obligation.

Which criteria are necessary for recognizing an estimated loss from a contingency and a related liability?

It is probable that an asset has been impaired or that a liability has been incurred, the amount of the loss can be estimated with reasonable precision.

What is a characteristic of accounting for noncurrent assets?

It is initially recognized when a firm can control probable benefits of the asset.

This year, a toy company switched from the FIFO cost-flow assumption to the LIFO cost-flow assumption for its inventories and cost of goods sold.

A change in accounting principles

Which primary asset measurement for inventory affects accounting quality?

Inventory method choice

Which statement accurately depicts accrual accounting?

Accruals have varying levels of persistence, with non-working capital accruals being more persistent.

What is a possible indication of earnings manipulation?

A large increase in the Days' Sales in Receivables Index (DSRI)

Which statement explains the Beneish Manipulation Index?

Messod Beneish developed the 8-factor and 12-factor models using data for firms subject to SEC enforcement actions related to fraudulent accounting reports, and not all factors attempt to capture the existence of earnings manipulation.

Which two statements explain the possible errors in the Beneish Manipulation Index? Choose two answers.

Committing a Type I error means failing to identify the firm as an income manipulator when it is one, and identifying a firm as an income manipulator when it is not one is committing a Type II error.

What is a possible indication of the existence of a heightened incentive managers might face that might lead to earnings manipulation?

An increase in the Sales Growth Index (SGI)

A toy store shows a Depreciation Index (DEPI) of 1.5.

What does this ratio indicate?

The store’s rate of depreciation has decreased, which decreases earnings.

A firm has a Selling and Administrative Expense Index (SAI) of 1.8.

The firm expensed rather than capitalized various costs, and there was an Increase in marketing costs that will lead to increased future sales.